Use Any Further Pullbacks In Restaurant Stocks To Add Exposure

Baird recommends investors to use any further pullback in restaurant stocks to add positions. The firm believes the sector should revive after the first quarter of 2017 following tepid industry comps in December.

Baird’s survey indicated December comps of approximately -0.5 percent, solidly below levels in October–November (revised +2.0-2.5 percent) and third quarter (revised +2.7 percent), primarily due to weather issues.

As such, the brokerage cut its calendar fourth-quarter comps estimates by 50–150 bp for nearly all companies in its coverage.

But, the situation is expected to improve from the second quarter.

A Look Forward

“Although difficult weather comparisons pose a continued headwind for Q1-17, we expect better top-line momentum to emerge in Q2-Q4 as the industry cycles some of the issues that we believe weighed on 2016 results (combative election cycle, high inflation differential versus grocery channel),” analyst David Tarantino wrote in a note.

As 2017 unfolds, the industry should also benefit from macroeconomic environment, including favorable tax policy changes that in turn could boost spending.

“We still believe the near-term fundamental outlook for limited-service chains (fast-casual, specialty coffee, QSR) is stronger than for casual dining. As such, our Outperform ratings remain concentrated within the limited-service segments of our coverage,” Tarantino highlighted.

Recommendations

The analyst recommends Panera Bread Co PNRA, Starbucks Corporation SBUX, Habit Restaurants Inc HABT, Buffalo Wild Wings BWLD and Zoe's Kitchen Inc ZOES, as they are appear poised to deliver above-average earnings growth via a top-line driven model. Strong internal sales drivers could also shield these firms if spending doesn’t improve as expected.

In addition, Tarantino prefers Buffalo Wild Wings, McDonald's Corporation MCD, Dunkin Brands Group Inc DNKN for their defensive business models along with an attractive risk/reward profile.

Regarding special situations, Tarantino sees value in Jack in the Box Inc. JACK, Buffalo Wild Wings and McDonald’s. Jack in the Box and McDonald’s are transforming their business models, while Buffalo Wild Wings could pursue value-creating initiatives amid presence of an activist investor.